How expert is the person managing your pensions and investments? Can they beat the market? And if not, what on earth are you paying them for?
The cost of investing has been getting cheaper due to an explosion in the popularity of so-called passive investment funds. Ralph Benson examines how Irish savers can take advantage.
These questions have prompted people to move more than a trillion (yes, trillion) dollars of savings from ‘actively managed’ funds to ‘passively managed’ funds over the last 10 years, according to the Investment Company Institute.
Passive is simple
Passive, or indexed, funds have a simple aim. They mimic the performance of a market – say, the S&P500 index of top US companies.
Own passive investments, and your money is guaranteed to grow if the market goes up, and shrink if it goes down. No better, no worse. And a lot cheaper.
By contrast, an active fund manager charges more and offers the promise of beating the market, for example, through sector insight, experience and specific trading strategies.
Active has had a tough few years
The trouble for fund managers is, many savers have found it a lot more profitable to let their money track a major stock market index than pay a fund manager to pick and mix.
Ireland’s life companies have been forced to respond, launching cheaper passive fund ranges which are designed to do what the market does.
Choose passive investments and you’ll typically save at least 0.25% in annual management charges. That might seem small, but over the years, these costs significantly hit your investment returns.
A €100,000 investment over 30 years at a fund charge of 0.75% would return €691,460. That’s over €50,000 more than if the fund charge were 1%! (Small print: this is based on annual growth of 8% and an advisory/ platform fee of 0.5% in each case).
So what’s the catch?
We see three main downsides to passive investments in the Irish market right now.
First, passive fund management on this scale is untested in a choppy market. The large-scale move to indexing has occurred at the same time as an 8-year growth period in markets, propelled by low interest rates.
Nobody really knows what happens these passives if there is a short-term wobble in the markets.
Some assembly required
Then there’s the need for diversity. Every serious investor needs to think about holding a diverse range of investments. That’s why investment funds are so useful – they give instant access to a wide range of underlying investments.
But index funds struggle to be truly diverse.
For example, there’s no good way to passively manage a property portfolio. So with a passive investment strategy, you’re at risk of leaving out entire asset classes.
In addition, if your investments are all passive, you’re going to have to do some managing yourself.
Over time, it’s likely the risk and growth profile of your assets will alter. You might want to sell out of some markets that have run their course, or buy into others that have further to go. That’s called rebalancing, and if you’re a pure indexer, it’s a DIY job.
Not cheap enough
That brings us to the third big reason. Whisper it: passive investments just aren’t cheap enough in the Irish market.
One reason is that the passive funds marketed by Irish insurance companies often aren’t 100% passive. Maybe they will have some holdings of actively managed property, or hedge some exposures to manage their risk profile… all of which adds to the cost.
In fact, many passive funds in the Irish market can be around five more expensive than similar offerings in the US. There is still lots of room for improvement.
Right now, we believe a saving of something like a quarter of one per cent just isn’t exciting enough to give up on fully active management.
Get active, get fit
But that doesn’t mean you’re losing out. In fact, the biggest benefit to Irish investors from the rise of indexing is that active managers are pulling their socks up. And pushing their prices down.
Fund managers have begun to realise they need to adapt if they want a long-term future.
That means more openness, more genuine expertise and specialisation, and better prices. And that’s good news for all of our pensions and investments.
This does require one bit of active management from you, however.
Fund managers aren’t exactly volunteering to reduce costs for existing investors. It’s more likely you’ll cut your cost by switching to better priced funds, fit for the new pricing landscape.
We live in an era where ‘experts’ have to earn our trust. The investing industry is no different.
All details and information provided within this article are for general informational purposes only and should not be used as the basis for any form of agreement or advice. It is of a generic nature and does not take into account your own particular circumstances. Moneycube.ie makes no representations as to its accuracy and will not be liable for any errors, omissions or losses arising from its use.